Vitru Limited (NASDAQ:VTRU) Shares Could Be 35% Below Their Intrinsic Value Estimate

May 31, 2021
  •  Updated
November 29, 2022
NasdaqGS:VTRU
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In this article we are going to estimate the intrinsic value of Vitru Limited (NASDAQ:VTRU) by taking the expected future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. There's really not all that much to it, even though it might appear quite complex.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for Vitru

The method

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF (R$, Millions) -R$224.0m R$33.0m R$143.0m R$186.0m R$217.0m R$239.8m R$258.9m R$274.8m R$288.3m R$300.0m
Growth Rate Estimate Source Analyst x1 Analyst x2 Analyst x1 Analyst x1 Analyst x1 Est @ 10.51% Est @ 7.95% Est @ 6.17% Est @ 4.91% Est @ 4.04%
Present Value (R$, Millions) Discounted @ 8.9% -R$206 R$27.8 R$111 R$132 R$142 R$144 R$142 R$139 R$134 R$128

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = R$893m

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 8.9%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = R$300m× (1 + 2.0%) ÷ (8.9%– 2.0%) = R$4.4b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= R$4.4b÷ ( 1 + 8.9%)10= R$1.9b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is R$2.8b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$14.9, the company appears quite good value at a 35% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf
NasdaqGS:VTRU Discounted Cash Flow May 31st 2021

The assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Vitru as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 8.9%, which is based on a levered beta of 0.907. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Moving On:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Can we work out why the company is trading at a discount to intrinsic value? For Vitru, we've compiled three additional items you should further examine:

  1. Risks: For instance, we've identified 1 warning sign for Vitru that you should be aware of.
  2. Future Earnings: How does VTRU's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
  3. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQGS every day. If you want to find the calculation for other stocks just search here.

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